Over-the-counter (OTC) securities are securities that are not listed on a major exchange in the United States and are instead traded via a broker-dealer network, usually because many are smaller companies and do not meet the requirements to be listed on a formal exchange. There may be additional steps and fees when trading OTC securities because trades must be made through market makers who carry an inventory of securities to facilitate trading.
There are approximately 10,000 OTC securities that make up a wide array of different companies, including large-cap American Depositary Receipts (ADRs), foreign ordinaries, and small and micro-cap growth companies. While some OTC securities report to the Securities and Exchange Commission (SEC), others may follow a different reporting standard or may not file reports to any regulatory body.
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Understanding the risks of OTCs
OTC securities present a number of additional risks, compared to securities that trade on a national exchange.
Lack of publicly available information
The biggest difference between an OTC stock and a listed stock is the amount of publicly available information about the company. Information about OTC companies can be difficult to find, making them more vulnerable to investment fraud schemes and making it less likely that quoted prices in the market will be based on full and complete information about the company.
No minimum listing standard
Companies quoted on OTC Markets generally do not have to meet any minimum standards, although companies quoted in OTC Market Group’s OTCQX and OTCQB marketplaces are subject to initial and ongoing requirements.
Business and financial risk
While all investments involve risk, microcap stocks (market capitalization of $50 to $300 million) are among the most risky. Many microcap companies are new and have no proven track record. Microcap stocks often have low trade volume. Any size of trade can have a material impact on the price.
OTC stocks have less liquidity than their exchange-traded peers, low trading volume, larger spreads between the bid price and the ask price, and little publicly available information. This results in them being volatile investments that are usually speculative in nature. Additionally, due to the nature of the OTC marketplace and the characteristics of the companies that trade OTC, investors should conduct thorough research before investing in these companies.
Types of OTC tiers
OTC Markets Group, a third party, has created three tiers based on the quality and quantity of publicly available information. These tiers are designed to give investors insights into the amount of information that companies make available. Securities can move from one tier into another based on the frequency of financial disclosures. The tiers give no indication of the investment merits of the company and should not be construed as a recommendation.
This is considered the highest tier of OTC Markets' securities based on the amount of available information. In order to be eligible for the OTCQX tier, the firms must be current on all regulatory disclosures, maintain audited financials, and cannot be a penny stock, a shell corporation, or be in bankruptcy.
This tier is designed for early-stage or growth companies. Companies must have a minimum bid price of $0.01. These companies must be current in their regulatory reporting and have audited annual financials in accordance with U.S. Generally Accepted Accounting Principles (GAAP). Similar to OTCQX, these companies cannot be in bankruptcy.
Pink Market ("Pink Sheets")
This tier is also known as the Open Market. There are no minimum financial standards, and it can include a wide variety of companies, including foreign companies, penny stocks, shell companies, and other firms that choose not to disclose financial information. Within the Pink Market, firms are classified as showing Current Information, Limited Information, or No Information.
All other securities that are traded over-the-counter are on the Grey Market. Grey Market securities are not quoted by broker-dealers due to a lack of investor interest, lack of financial information, or lack of regulatory compliance.
Your approach to investing in OTCs depends on what type of investor you are. At Schwab, we provide the help you need to build a strong portfolio, whichever way you prefer to invest. You can buy and sell OTCs on your own with a Schwab One® brokerage account or call 877-566-0054 to talk to an experienced specialist about whether OTCs are right for you.
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